Buy-sell Agreement Funded by Life Insurance for Multi-Owner Businesses
by Richard S. Bernstein on Mar 2, 2018
Recently, I met a business owner who found himself in the following circumstance. His business partner recently passed away. It was a week after the funeral, and his office was addressing how they were going to handle the loss to the company, both in an operations capacity and emotionally. That day, the late business partner's two sons showed up, but they weren't there to clean out their father's office.
Rather, they were claiming that they were now partners of the business, and had the same managerial rights as the late business partner, including crucial financial and staffing decisions. So there this business owner was, with two new business partners that he only knew from occasional social functions. Neither of the sons had any prior experience in the industry, and all of a sudden they were now controlling members of a company that had seen more than two decades of success. This entire situation could have been avoided if the company had drafted a buy-sell agreement that was funded by life insurance.
When a Business Partner Passes Away
Businesses that have multiple owners, by their nature, are structured where each owner has a monetary interest in the business proportional to their equity share. When a business partner passes away, his or her interest becomes part of his or her estate. The family of that business partner is entitled to the interest that the partner owned. If there is no financial agreement between that partner’s estate and the business, there are only two options, neither of which are chosen by the surviving owners. Either you liquidate the business to pay the equity interest owed to the late partner’s family, or you must accept the late partner's spouse or heirs as your new business partners.
Any business that has multiple owners should plan for the continuation of a business in the event of a partner’s death. Buy-sell agreements are one of the most common and efficient ways to fund these plans, as they transfer the business interests to the late partner’s estate immediately upon death. This allows the business to resume operations quickly and satisfy the late partner’s estate. The additional benefit that it provides is the assurance of the employees, investors and even clients during the transition period.
The core of a buy-sell agreement is that it’s funded so that the necessary capital is available at the time of death. The standard and preferred funding vehicle for buy-sell agreements is life insurance. It is the most efficient way to produce the necessary funds after a business partner’s passing. A life insurance policy owned by the business can also have additional provisions in it that provide the liquidity often needed to replace a key member of a company.
A buy-sell agreement may be one of the most important risk planning tools a business ever creates. It’s a vital legal document that should be drafted by a top-notch group of advisors, comprising of a business attorney, insurance advisor, and the financial controller of the company, such as a CPA. Additionally, there are tax implications involved for the business owners and the partners’ estate, so a qualified tax professional should also be involved.
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